Behavioral Finance and its impact on your decisions

In these uncertain times, proficiency can bring clarity to people concern about today’s undecided markets. It is crucial to separate emotion from investing and make better financial decisions and avoid behavioral bias. Understand behavioral finance can help us to avoid emotional actions that can direct to losses and consequently come up with an appropriate management strategy.

What is Behavioral finance?

You could say behavioral finance came about as a way to explain in a rational way the irrational behavior of markets and investors or, as one acclaimed economist put it, finance from a broader social science perspective including psychology and sociology ( Miller, 2019). How do changes in financial decision making can help during these times? How often do people adopt financial behavior that works in various situations?  This is where diagnosing your own decision making can help improve the chances of creating better outcomes in the midst of the chaos that is life.

Financial decisions

Decisions regarding finances are often most consequential when we are busy, troubled, and flat out overwhelmed. In the past few months, many investors have made tough choices on the things most important to their financial goals, and this will likely remain in the months ahead. A large portion of the population is struggling to feed their family, let alone contemplating large life expenses such as buying homes, cars, saving for college or retirement and so forth (Kudla,2020). Someone who has the capability to identify the deficiency in his or her behavior can improve his or her decision and learn from the errors.

Traditional financial theory and behavioral finance

Traditional financial theory holds that markets and investors are rational; investors have perfect self-control and are not confused by cognitive errors or information processing errors. Now, according to the Corporate Finance Institute, behavioral finance holds that investors are considered « normal », not « rational »,  they have limits to their self-control, are influenced by their own biases, and make cognitive errors that can lead to wrong decisions ( Miller, 2019).

Fear and greed can have a tremendous impact on trading patterns from a behavioral finance point of view. Such emotions can lead to panic buying, confirmation bias, memory bias, framing, crowding, overconfidence, FOMO, and fire sale. But all these biases make us human beings, who are emotional and irrational and who invest in stocks based on our beliefs (Sultanov,2020).

Investments and behavioral finance

These days, asset managers take seriously the behavioral components of investing, and with good reason. Even after working with a financial advisor on an investment policy statement based on risk tolerance and objectives, investors often react in the moment or have trouble shedding long held beliefs that may hurt their returns (Stalter,2015). According to behavioral finance, the majority of trading mistakes are made due to emotions. This makes fear and greed the main risk factors in any trading strategy. In that sense, robots are much better emotionless traders. However, the shortcoming of robotrading strategies is their inability to factor in and capture all market trends, emotions, fears, beliefs, macro understanding and risk management.

This is why it’s important to combine human decision-making and automated tools, which boost and yield-enhance by adding magnitude (Sultanov 2020). Sometimes investors make decisions based on emotion, not logic or common sense, in this cases panic and speculation take place.

Behavioral finance works to cover the rationality, in order to make good financial decisions people need to stay rational.

 *Exploring  New research on behavioral finance*

Investors are human, and therefore have the tendency to make emotional, biased investment decisions. Understand the psychological or emotional factors that predispose investors to behavioral biases can help advisors differentiate their services and ultimately better serve their clients (De St. Paer, 2019). Behavioral finance combines psychology, economics and other social sciences and the multidisciplinary study to understand why people make financial choices and decisions and help to build better portfolios. Behavioral Finance has been part of some major research. There have being an enormous growth in the field of AI-based applications and technical issues that are related to behavioral finance. For many years, organizations have used Financial DNA to help and keep clients. Financial DNA can provide practical understanding to people who have behavioral differences.Incorporating behavioral financial into their practice is key to enhancing the client experience, deepening relationships, retaining clients, and potentially delivering better outcomes (De St. Paer 2019).

*Fregens DONATIEN*

MScM, Master of science Management, Eastern Nazarene College, Massachusetts USA    

Doctoral Student, Doctoral Business Administration (DBA), Liberty University, USA.

*References :*

Kudla D., (2020) Human Behavior and how it impacts your finances. www.Forbes.com

Miller T. (2019), Behavioral Finance: Concepts, examples and why it’s important.

https://www.the street.com/personal-finance/education/behavioral-financial-14909070

Sultanov A., (2020) Managing Fear and Greed During Market turmoil.www.Forbes.com

De St.Paer J. (2019), Why behavioral finance is important in today’s market environment.www.Linkedin.com

Stalter K. (2015) 7 Behavioral Biases that may hurt your investments. www.money.usnews.com